Every nationalistic bailout this year has been accompanied by global stock
exchanges and debt markets plunging to new lows. More specifically, the biggest
rescue in history saw the biggest Monday to Friday plunge in the Dow since
1914, which exhausted the latest panic. The conflict between ambitious policymakers
and implacable market forces has become immense. The former have been sophisticated
in theories but naïve about financial manias and their consequent busts.
Indeed, market history, itself, is a "due diligence" on every great financial
scheme, whether it has been promoted by Wall Street or by financial adventurers
in policymaking.

Promises from the latter have been imaginative and range from being able,
through certain manipulations, to "keep the recovery going", or if that is
not working other manipulations will "prevent a slowdown" and then, as desperately
needed, certain other efforts will "end a panic". If one accepts the first
two premises the last one is impossible. Considering the enormity of the crash
it seems likely that FOMC deliberations about administered rates will eventually
lose their cachet. Professional Fed watchers may have to find supplemental
employment.

Previous post-bubble contractions have prompted chagrin as well as a rush
of recriminatory legislation, but claims from today's interventionists that
the crash is a result of not enough regulation are absurd. The SEC and Glass-Steagall
were regulations designed to prevent another 1929 bubble that obviously weren't
effective.

There have been financial crashes for as long as there have been markets.
Moreover, since the 1500s documentation is rather good with the recurring theme
that blossoms with a bust is some intellectual will provide personal revelations
that the disaster need not have happened if only more credit was available,
or if only interest rates had been kept from rising. From Missleden following
the 1618 disaster to Keynes following the 1929 disaster the revelations have
been adequately documented as same old, same old.

This time around, chronic application of intuitive theories has resulted in
the biggest credit bubble in history, and, so far it is being followed by the
biggest contraction in history, which is again prompting knee-jerk remedies.

Actually similarity goes beyond responses by officials. Financial manias and
consequent contractions have been methodical. So methodical that it should
be taught in basic economics.

Firstly, it should be understood that there is nothing that can be done to
prevent a financial mania when the markets want to have one. In the past the
most dangerous have encompassed both tangible and financial assets. There have
been five examples from the South Sea Bubble in 1720 to the 1929 blowout. Also
it should be understood that the contraction is consequent to the boom.

The next step is to correct intuitive conventional wisdom that rising interest
rates are detrimental to a recovery. No - hundreds of years of data record
that rates increase during a boom. This is so reliable that it is an indicator
that all is well. Going the other way, interest rates decline during a contraction.
This is also so reliable that it is an indicator of a contraction. Furthermore,
the sharpest plunges in short rates have been associated with the worst bear
markets. Treasury bill rates have declined to 0.0% with this calamity. Belief
that an arbitrary attempt to lower rates will restore a boom seems to be derived
out of thin air.

Another blunder of our times is the notion that rising commodities are detrimental.
No - throughout all of recorded business history rising prices have been associated
with prosperity. And for the same length of time, falling prices have been
associated with hard times.

And as mentioned above, the other classic error is to imagine that adding
credit to a contraction will prevent an existing credit contraction. Proponents
of this kind of thinking must have PhDs in Tautology.

More recently, the problem is that at the top of the stock market the street
was celebrating the return of "Goldilocks" which was the euphemism for the
genius of policymakers. With the official guarantee of no risk the street aggressively
employed margin, as central bankers provided "easy" money.

This contraction, as usual, is prompting many nostrums, none of which are
new as well as a lot of scapegoating, which isn't new either. That after such
recklessness the notion that a bust could have been prevented is a demonstration
that financial markets are not bereft of irony.

While central bankers have claimed to have been in control, a review of previous
great bubbles records that in a boom the street becomes supremely confident
and gets leveraged - to the hilt. In their inevitable way prices start down,
and although initially subtle, that marks the transfer of the baton of power
to margin clerks and de-leveraging proportionate to the boom follows.

Of course, there is a difference in job descriptions. For margin clerks it
has been to get the accounts in line. Considering a long run of serial bubble-blowing
the job description of your basic central banker has been to get the accounts
out of line. This year margin clerks have the power and policymakers and their
politicians just don't get it.

Booms and busts will continue to recur, and there has been no need for massive
and futile intervention. However, markets are poised for a natural, but brief
rebound, which will be celebrated as a great result of policy. The May rescue
was also considered a success: "The policy response to financial asset deflation
was not only extremely fast, but extremely well coordinated. US policymakers
deserve the Nobel Prize."

Doubtless that the central planning crowd has been shocked by the degree and
relentlessness of the contraction. But, the establishment is still claiming
that the collapse could have been prevented by even more intervention, so the
shock hasn't been severe enough to initiate self-examination of the role of
governments and their agencies in exaggerating financial volatility.

Fortunately history is providing perspective and as the saying goes in physics: "If
you keep your data base short enough it will fit your theory." For scholars
on contractions, such as Bernanke, the world starts in 1929 and ends in 1939.
He, like so many researchers, concluded that the guys running the Fed in 1929
made a mistake. There is much more to history than one bubble.

Beyond being bracketed by exuberance and recrimination, financial manias have
much in common. When speculation brews up the urge to borrow short and lend
long will be taken to the limit. This drives short rates up faster than long
rates and forces the yield curve to inversion. So long as the curve remains
inverted the boom is on.

Politicians enjoy the prosperity and there is no hard evidence of government
ever deliberately ending a mania. The notion that the Fed ended the Roaring
Twenties by raising the discount rate from 5% to 6% in August 1929 has been
an expedient to avoid criticizing the Fed's systemic inadequacies.

Short-dated market rates of interest began their decline in May, 1929 ominously
signaling the advent of that infamous contraction.

It should be added that when the senior central bank has been permitted to
aggressively change administered rates typically it has followed the key changes
in market rates by 3 or 4 months. That is at the start of a boom, as well as
at the end. In 1929 the Fed replicated what the Bank of England did at the
climax of the previous bubble in 1873.

It is worth emphasizing that while the Fed can briefly push short rates down
central bankers have no material influence on the curve. Fortunately, this
allows the curve to remain a reliable indicator of market forces and when it
reverses to steepening it has been the time when the wheels begin to fall off
the most blatant speculations. In the spring of 2007 this writer's advisory
service noted that a boom typically ran some 12 to 16 months against inversion
and this made that fateful June the sixteenth month. The curve reversed in
May marking the slide to contraction.

The other critical element in the reversal of fortune is the spread between
different bonds or money market instruments. With all the confidence that goes
with a boom investors reach for yield by buying riskier paper and this narrows
credit quality spreads. This is also a part of the credit world that not just
resists, but denies central bank influence and when it changes from narrowing
to widening that is another indicator of the developing contraction. Many markets
have seasonal tendencies and typically spreads narrow into May and then widen.
When participants are euphoric and policymakers are basking in the glory of
their fine works the change in spreads is the other warning device. This was
also accomplished in that fateful June.

By July, 2007 changes in credit markets were sufficient to conclude that "The
greatest train wreck in the history of credit." had started. Historically this
could become severe enough to prompt popular condemnation of the systemic inadequacies
of interventionist central banking.

In the 1830s and 1840s Samuel Loyd made a lot in finance and was regarded
as the foremost authority on money and banking. He wisely observed: "No warning
can save a people determined to grow suddenly rich."

In the 1600s when Amsterdam was the financial and commercial center of the
world the Dutch term for easy credit markets was "easy". With elegant language
use, the opposite condition was "diseased credit".

As with most impartial observations on markets, these are applicable now or
in any century in the past or in the future.

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